BOJ move impact a 'process'

But analysts watch for effect on bonds, commodities

By

WanfengZhou

NEW YORK (MarketWatch) -- The global impact from the Bank of Japan's epoch-making shift is likely to be more of a process than an event, and is unlikely to roil the U.S. and world financial markets, analysts said Thursday.

The Bank of Japan, by a vote of 7 to 1, concluded Thursday that economic and price conditions favor the return to a more normal monetary-policy position. See full story.

The central bank said it would encourage the overnight call rate to remain at effectively 0%, but would gradually seek to reduce the amount of cash it has been injecting into the banking system.

"Although there are indeed both short-and long-term implications to the Bank of Japan's policy change, it needn't send shudders throughout the world financial markets," Tony Crescenzi, chief bond market strategist at Miller Tabak.

"For one, it was largely expected and Japan's return to sustainable growth is good news for the global economy. Second, Japan's interest rates are likely to remain extraordinarily low for many more years," he said.

Charles Dumas, an analyst at Lombard Street Research, echoed that view, saying that the BOJ's removal of excess liquidity over the next few months has little short-term significance.

"The need for [excess liquidity] has evaporated, owing to stabilization of previously falling house prices, and the zero-rate policy," Dumas said. "Japanese households have plenty of liquidity already...Excess liquidity is superfluous."

"Keep in mind that it will be many years before Japan's policies can be considered tight, so the impact on world markets will be more a process than an event," Miller Tabak's Crescenzi said.

Yen falls

The Japanese yen knee-jerked lower immediately after the BOJ's move, then spent European and early New York trading sessions rising, before giving up gains to trade lower against both the dollar and the euro.

At last check, the dollar was changing hands at 118.31 yen, up 0.5%, while the euro was fetching 140.86 yen, up 0.3%. See Currencies.

Eddie Wong, ABN Amro's strategist in Hong Kong, said the policy change should have little impact in the short term, as liquidity conditions remain easy, but is yen-positive over the long term as it represents the first step to the end of Japan's super-accommodative monetary policy.

Analysts at KBC Securities, said the shift of the Bank of Japan is extremely important. "It will have a far-reaching effect in drying up the liquidity pool that may be a source of world funding," they said.

Joel Ward, manager of the Joel Nathan ForexFund, said the yen should see some strength as the Bank of Japan begins its interest-rate raising cycle.

"The general effect of raising interest rates in the currency market is a stronger currency as evidenced in the U.S. dollar's climb over the last 15 months. With that in mind, the yen should see some strength while that cycle continues," he said.

"The effects of Japan's new policies may take a back seat to the market's perception of any additional Fed rate increases," Ward said.

Meanwhile, Fergal Smith, an analyst at research firm Action Economics, expects the yen to weaken over the coming weeks. He said the BoJ's pledge to maintain an environment of very low interest rates should keep the yen under pressure.

"From here, it appears yen weakness may take center stage, as the market now has now largely come to the realization that Japanese interest rates are not likely to rise to any significant degree anytime soon," he said. "The key point is how long they're going to stay at zero."

Bond fears

Japan holds $685 billion worth of U.S. Treasurys in its cache, the second largest holding next to the U.S. Federal Reserve's $736 billion, Miller Tabak's Crescenzi noted.

The bond market has worried that the Bank of Japan's tightened monetary policy could influence the central bank to reduce its U.S. Treasury holdings.

Crescenzi said these fears, while legitimate, are overblown.

"With Japan likely to continue to earn dollar reserves and with its period of diversification already progressed, Japan is not likely to be a major seller of Treasurys for some time," he said.

The euroyen futures market showed that Japan's benchmark rate is expected to end 2006 at just 0.5%, and will be at just 1.12% at the end of 2007. The rate is expected to end 2008 at 1.55%.

"That [rate] is low enough to encourage continued Japanese purchase of foreign assets, although the motivation won't be as strong as before," Crescenzi at Miller Tabak said.

Commodities

Crescenzi said one key impact to watch is how the BOJ's tightening, as well as continued rate hikes in by European Central Bank and the Federal Reserve, weighs on commodity prices and whether it forces an unwinding of commodity-related trades.

"The collective impact of monetary tightening in Japan, Europe and the U.S. is a bearish factor for the commodity market," Crescenzi said. "There are sizable financial positions held in stocks, bonds, commodities and currencies all geared toward rising commodities prices."

Peter Grandich, editor of the Grandich Letter, said the BoJ's move bodes well for the gold.

"Today's action by the BOJ will be looked back a year from now as the watershed event that began the beginning of the end for the U.S. dollar, which has been propped up from the now defunct "Yen carry-trade," Grandich.

"With Europe also moving away from 'easy money,' the economic nightmares of U.S budget and trade deficits, combined with the fact that Americans have been robbing Peter to pay Paul but Peter is broke, is going to ignite gold as the No. 1 alternative currency to own."

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